NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of MDU Resources Group, Inc. (MDU; Issuer Default Rating [IDR] 'BBB+'), its regulated gas distribution utility subsidiary, Cascade Natural Gas Corporation (Cascade; IDR 'A-'), and Centennial Energy Holdings, Inc. (CEH; IDR 'BBB'), the holding company for MDU's non-utility operations. The Rating Outlook is Stable for all three entities. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
MDU
The ratings recognize MDU's improved business profile following its recent divestiture of the volatile exploration and production (E&P) operations, the ownership of four low-risk electric and gas utilities that operate in relatively balanced regulatory environments and serve parts of eight contiguous states from Minnesota to Washington, higher margins at CEH driven by growth of the economically sensitive construction group, low operating leverage, and sound consolidated credit metrics for the current rating category.
MDU received proceeds and tax benefits of approximately $500 million from the oil and natural gas asset sales, which are being used to pay down outstanding E&P debt and fund capex. Consolidated capex is projected to decline with the capital-intensive upstream operations now disposed of. Management plans to spend approximately $2.3 billion of capex over 2016-2020, compared with $3.6 billion over the last five years, amounting to a 36% drop. Fitch estimates regulated utilities' share of consolidated capital investments will grow to approximately 65% of total capex over 2016-2020, compared with roughly 30% in 2014, when the upstream segment represented the bulk of investments.
Accordingly, Fitch forecasts the regulated utilities to generate 40%-45% of consolidated EBITDA compared with 24% back in 2014 when E&P's share was 40%. Utilities' earnings and cash flows should benefit from a number of rate decisions expected in various jurisdictions in 2016. Utilities have $27.6 million in pending rate requests while another $27.6 million in interim rates has already been implemented. Rate design mechanisms are generally supportive of credit quality. Some regulatory jurisdictions allow the use of decoupling and riders for investments in renewables, transmission and environmental equipment. All jurisdictions allow trackers for fuel and purchased power costs, and a purchased-gas adjustment clause for gas utilities. Fitch assumes balanced rate outcomes in all rate cases.
The key credit concern is MDU's cash flow exposure to unregulated operations, which has diminished but remains present nonetheless. Fitch projects CEH's unregulated operations will contribute a meaningful 45%-50% of MDU's EBITDA over the next five years. We estimate the construction materials and construction services businesses will represent approximately 76.5% of CEH's EBITDA over 2016-2020, with the remainder generated by the pipeline and midstream segment, which consists primarily of FERC-regulated pipeline operations. On a positive note, these businesses are financially sound, operate with low leverage and are not capital intensive. Fitch recognizes MDU's continued commitment to manage the balance sheet of these operations in a conservative manner.
Credit metrics are adequate but have limited headroom at current rating levels. Fitch expects EBITDAR and FFO coverage ratios to average 4.5x and 4.2x, respectively, over 2016-2018. Adjusted debt/EBITDAR is projected to average 3.7x over the same timeframe. For the LTM 1Q16, EBITDAR and FFO coverage ratios stood at 3.4x and 3.5x, respectively, while adjusted/debt/EBITDAR was 4.7x.
CASCADE
Cascade's ratings reflect the low-risk nature of its regulated gas distribution assets that operate in relatively balanced regulatory environments in Washington and Oregon, a constructive settlement in its pending Washington rate case, projected improvement in credit metrics, and adequate access to liquidity including parent cash infusions if required. Cascade represents approximately 40% of MDU's gas utilities EBITDA and 20% of combined electric and gas utilities EBITDA. Washington represents nearly 90% of Cascade's rate base.
The utility reached a settlement in its pending Washington rate case that provides a base rate increase of $4 million effective September 2016. Importantly, the Washington Utilities and Transportation Commission (WUTC) authorized Cascade to implement a revenue decoupling mechanism that insulates net revenues from the effects of weather, energy efficiency and conservation, and customer demand.
Fitch forecasts credit metrics will strengthen over the forecast period following a relatively weak 2015 financial performance principally due to lower customer demand. EBITDAR and FFO coverage ratios are expected to average 5.2x and 4.6x, respectively, over 2016-2018 while adjusted debt/EBITDAR is projected to average 3.7x over the same timeframe. For the LTM 1Q16, EBITDAR and FFO coverage ratios stood at 4.9x and 3.4x, respectively, while adjusted debt/EBITDAR was 3.9x.
We anticipate Cascade's capital spending will continue to rise modestly over the next few years, with capex earmarked towards infrastructure build and replacement of aging pipes. On a positive note, the utility has a pipeline replacement rider in Washington that provides timely recovery of costs through annual revenue adjustments outside of rate cases.
Cascade's credit profile benefits from ring-fencing mechanisms that insulate the utility from MDU's other regulated and unregulated businesses. Ring-fencing mechanisms include no Cascade guarantees or cross-default provisions within debt agreements at other MDU entities which could impact Cascade, a prohibition on intercompany loans, and dividend restrictions.
CEH
CEH's ratings reflect a diverse business mix that includes construction and pipeline/midstream, sound credit metrics, low leverage, modest capex requirements, and adequate liquidity. Since the E&P divestiture, CEH has transitioned to a business model primarily geared towards the construction materials and construction services businesses, with pipeline/midstream adding some level of earnings diversity. Fitch estimates the construction businesses will generate, on average, about 80% of CEH's consolidated EBITDA over 2016-2020. Historically those businesses have done relatively well and have built up a significant backlog of projects going into 2016, which should help boost earnings and cash flows over 2016-2017. Further earnings opportunities should arise in the intermediate term given the passage of the new $305 billion long-term highway bill in December 2015.
The seasonal and cyclical nature of the construction industry continues to be the main rating concern. In addition, Fitch will closely monitor management's assessment of strategic alternatives for its 50% ownership interest in the Dakota Prairie Refinery. The refinery has suffered financially from adverse commodity pricing and lower diesel demand since it came online in mid-2015 and MDU has indicated impairment charges are a possibility if market conditions persist. An exit from the refining business would be a positive development.
Forecasted credit measures are consistent with the current rating category. Fitch expects EBITDAR coverage and leverage ratios to average 11.4x and 2.1x, respectively, over 2016-2018. The financial profile benefits from a modest financial leverage position with debt-to-total capitalization managed around 35%-40%. For the LTM 1Q16, EBITDAR coverage and leverage metrics were 5.2x and 3.8x, respectively, reflecting weaker EBITDAR from the exit of the E&P business.
CEH's ratings take into consideration the benefit of ownership by MDU, which can provide parental support through cash infusions if needed. In addition, CEH enjoys good financial flexibility, as reflected by the ability to access its own liquidity and issue debt on its own.
NOTCHING
MDU retains a divisional structure so that the legacy utility is in fact the parent company. All the debt at MDU represents divisional utility debt. As a result, MDU's senior unsecured debt is rated one-notch above its IDR, consistent with Fitch's utility notching convention. Utility debt is serviced at the operating company level for MDU and its gas utility subsidiaries Cascade and Intermountain Gas Co. (Intermountain). The legal structure which isolates the non-utility businesses within CEH, a non-recourse holding company, from the rest of the MDU corporate family is a factor in the ratings. In its notching considerations, Fitch restricts the IDRs of MDU and its two subsidiaries to a one-notch separation. The one-notch differential illustrates the potential parental funding support provided by MDU to Cascade and CEH, the strategic and financial importance of those businesses, and the relatively modest size of the utility.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case are as follows:
MDU
-EBITDA margins range between 13%-16% over 2016-2020;
-Capex averages $460 million annually over the next five years;
-No bonus depreciation.
CASCADE
-Rate increase as per Washington rate case settlement;
-Capex averages $50 million annually over the next five years.
CEH
-EBITDA margins range between 11%-12.5% over 2016-2020;
-Capex ranges between $50 million-$200 million annually over the next five years;
-Construction contributes approximately 80% of CEH's EBITDA;
-No material earnings contribution from the refinery.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
MDU
Continued shift in earnings and business mix towards regulated businesses coupled with adjusted debt/EBITDAR below 3x.
CASCADE
Given the limited headroom in credit metrics for the current ratings, a positive rating action is unlikely in the near term.
CEH
A greater focus on FERC-regulated investments coupled with adjusted debt/EBITDAR below 1.5x.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
MDU
--A material deterioration of the regulatory environments in which the utilities operate;
--A significant and prolonged economic downturn at the construction segment;
--Further expansion into unregulated businesses leading to higher leverage;
--Adjusted debt/EBITDAR between 3.5x-3.75x on a sustained basis.
CASCADE
--A downgrade of MDU;
--Unexpected deterioration in the regulatory compacts;
--Adjusted debt/EBITDAR greater than 3.75x on a sustained basis.
CEH
--A significant and prolonged downturn at the construction segment;
--Further expansion into unregulated businesses leading to higher leverage;
--Adjusted debt/EBITDAR greater than 2.75x on a sustained basis.
LIQUIDITY
MDU and subsidiaries have adequate liquidity for working capital and other short-term funding requirements. As of March 31, 2016, MDU had $91 million of cash and cash equivalents and availability under its four revolvers was $586 million. Both MDU and CEH maintain commercial paper programs backed by revolvers. MDU's own revolver is for $175 million and matures in May 2019. Cascade's $50 million revolver expires in July 2018. Intermountain's $65 million revolver expires in July 2018. CEH's $650 million revolver expires in May 2019. All four bank agreements restrict the debt-to-capitalization ratio from exceeding 65%.
FULL LIST OF RATING ACTIONS
Fitch affirms the following:
MDU Resources Group, Inc.
-- Long-Term IDR at 'BBB+';
-- Short-Term IDR and commercial paper (CP) at 'F2';
-- Senior unsecured at 'A-';
-- Preferred stock at 'BBB'.
Cascade Natural Gas Co.
-- Long-Term IDR at 'A-';
-- Short-Term IDR at 'F2';
-- Senior unsecured at 'A'.
Centennial Energy Holdings, Inc.
-- Long-Term IDR at 'BBB';
-- Short-Term IDR and CP at 'F2';
-- Senior unsecured at 'BBB'.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879564
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